Lecture Managerial accounting: Creating value in a dynamic business environment (10th edition): Chapter 11 - Ronald W. Hilton, David E. Platt

After completing this chapter, you should be able to: Distinguish between static and flexible budgets and explain the advantages of a flexible overhead budget; prepare a flexible overhead budget, using both a formula and a columnar format; explain how overhead is applied to Work-in-Process Inventory under standard costing;...

Flexible Budgeting and Analysis of Overhead Costs Chapter 11

Flexible Budgets

Static budgets are

prepared for a single,

planned level of activity.

Performance evaluation

for overhead is difficult

when actual activity

differs from the planned

level of activity.

Hmm! Comparing static budgets with actual costs

is like comparing apples and oranges

Advantages of Flexible Budgets

Improve performance evaluation.

May be prepared for any activity level in the relevant range.

Show revenues and expenses that should have occurred at the actual level of activity

Reveal variances due to good cost control or lack of cost control.

Variable Total Flexible Budgets

Total fixed cost

Total overhead costs

Preparing a Flexible Budget

Variable Total Flexible Budgets

Total fixed cost

Total overhead costs

Preparing a Flexible Budget

Variable costs are expressed as

a constant amount per hour.

Fixed costs are expressed as a total amount that does not change within the relevant

range of activity

Preparing a Flexible Budget

Preparing a Flexible Budget

Preparing a Flexible Budget

Note: There is no flex

in the fixed costs.

Preparing a Flexible Budget

Budgeted variable Total

Flexible Budget

Performance Report

Variable Total Cost Fixed Flexible Actual Per Hour Costs Budget Results Variances

Flexible Budget

Performance Report

Variable Total Cost Fixed Flexible Actual Per Hour Costs Budget Results Variances

Flexible budget is prepared for the same activity level (8,000 hours) as actually achieved.

Flexible Budget

Performance Report

Variable Total Cost Fixed Flexible Actual Per Hour Costs Budget Results Variances

Variable costs

Indirect labor $ 4.00 $ 32,000 $ 34,000 $ 2,000 U Indirect material 3.00 24,000 25,500 1,500 U Power 0.50 4,000 3,800 200 F Total variable costs $ 7.50 $ 60,000 $ 63,300 $ 3,300 U Fixed Expenses

Depreciation $ 12,000 $ 12,000 $ 12,000 0

Insurance 2,000 2,000 2,000 0

Total overhead costs $ 74,000 $ 77,300 $ 3,300 U

Flexible Budget

Performance Report

Variable Total Cost Fixed Flexible Actual Per Hour Costs Budget Results Variances

Depreciation $ 12,000 $ 12,000 $ 12,000 0

Insurance 2,000 2,000 2,000 0

Total overhead costs $ 74,000 $ 77,300 $ 3,300 U

Indirect labor and indirect material have

unfavorable variances

because actual costs

are more than the flexible budget costs

Flexible Budget

Performance Report

Variable Total Cost Fixed Flexible Actual Per Hour Costs Budget Results Variances

Total overhead costs $ 74,000 $ 77,300 $ 3,300 U

Power has a favorable

variance because the

actual cost is less than

the flexible budget cost.

Overhead Application in a Standard

Difference lies in the

quantity of hours used.

Actual Applied Applied overhead overhead: overhead:

Standard Standard allowed hours allowed hours

Predetermined Predetermined overhead rate overhead rate

Normal Costing

Manufacturing Overhead Work-in-Process Inventory

Manufacturing Overhead Work-in-Process Inventory

Standard Costing

Overhead Application in a Standard

Costing System

Budgeted Overhead

Variable 60,000 $ * 8,000 machine hours 7.50 $ per process hour Fixed 14,000 * 8,000 machine hours 1.75 per process hour Total 74,000 $ 8,000 machine hours 9.25 $ per process hour

* From the flexible budget for planned activity of 8,000 machine hours

Planned Monthly Activity

Predetermined Overhead Rate

Choice of Activity Measure

Variable overhead and the activity measure should vary in a similar pattern.

Identify variable overhead cost drivers.

Examples: machine hours, labor hours, process time.

Dollar measures should be avoided

as they are subject to price-level changes.

Spending

AH × SVR

AH × AR

AH = Actual Hours of Activity

AR = Actual Variable Overhead Rate SVR = Standard Variable Overhead Rate

SH × SVR

Actual Flexible Budget Flexible Budget Variable for Variable for Variable

Overhead Overhead at Overhead at

Incurred Actual Hours Standard Hours

Variable Overhead Variances

Spending

AH × SVR

Actual Flexible Budget Flexible Budget Variable for Variable for Variable

Overhead Overhead at Overhead at

Incurred Actual Hours Standard Hours

Variable Overhead Variances

Spending variance = AH(AR - SVR) Efficiency variance = SVR(AH - SH)

Budget

PFOHR = Predetermined Fixed Overhead Rate

SH = Standard Hours Allowed

SH × PFOHR

Actual Fixed Fixed Fixed

Overhead Overhead Overhead

Incurred Budget Applied

Fixed Overhead Variances

PFOHR =

Applied Fixed Overhead = PFOHR × Standard Hours

Budgeted Fixed Overhead Planned Activity in Hours

Fixed Overhead

Recall that fixed overhead costs are applied to products and

services using a predetermined fixed overhead rate

(PFOHR):

Fixed Overhead Variances –

A Closer Look

Results from paying more

or less than expected for

overhead items.

Results from the inability

to operate at the activity level planned for the period Has no significance for

cost control.

Overhead Cost Performance Report

Variable costs:

Indirect material:

Wax Plastic wrap Paper products Misc supplies Indirect labor:

Maintenance

J anitorial Utilities:

Electricity Natural gas Water Total variable cost

Fixed costs:

Indirect labor:

Inspection Production supervisor Set up

Depreciation:

Equipment Insurance Property taxes Total fixed cost

Total overhead cost

Activity-Based Flexible Budget

The Cheese Co.’s flexible

budget is based on a single

cost driver, machine hours

Activity-Based Flexible Budget

If different cost drivers are identified for the

different variable costs, an activity-based flexible

budget should be prepared with different cost

formulas based on the different drivers.

Standard Costs and Product Costing

Actual Applied Applied

overhead overhead: overhead:

Standard Standard allowed hours allowed hours

Predetermined Predetermined overhead rate overhead rate

Manufacturing Overhead Work-in-Process Inventory

Standard Costing

Standard Costs and Product Costing

Actual Applied Balance (1) Balance (2)

overhead overhead: Actual Applied

Standard overhead overhead

allowed hours greater than greater than

x Applied Actual

Predetermined overhead overhead

overhead rate Balance (1) Balance (2)

Balance (2) Balance (1)

Disposition of Variances

A General Model for Variance

Analysis

A ctual Q uantity A ctual Q uantity S tandard Quantity × × ×

A ctual P rice S tandard P rice S tandard Price

Materials price variance Materials quantity variance

Labor rate variance Labor efficiency variance

Variable overhead Variable overhead

spending variance efficiency variance

AQ(AP - SP) SP(AQ - SQ)

AP = Actual Price SQ = Standard Quantity

A General Model for Variance

Analysis

× × ×

ASV = Actual Sales Volume BSP = Budgeted Sales Price